Euro Area Money Demand Stability

Abstract

The European Central Bank (ECB) has price level stability as its primary target, and operates via an interest-rate measure to achieve its target over the short term. The ECB also explicitly incorporates a quantity measure, M3, into their monetary framework to help assess the medium to longer term risks to price level stability. Use of M3 by the ECB implies a stable relationship between money and prices. We analyzed the behavior of monetary aggregates, and concluded that the ECB’s use of M3 may have some merit over the medium to longer-term as an indicator of price pressure from a quantity theory of money perspective. But there appears to be a question as to stability of money demand since it is not clear if there is a constant interest-rate elasticity.  So, in practice, it remains unclear if the ECB gives much credence to any of the monetary aggregates. In particular, this applies to M3 since the ECB cannot directly control that measure.